Daniel Gross has a short item on this topic at Slate. He concludes that "the price movement tends to respond to conventional wisdom and polling data; it doesn't lead them." Thanks to Matt Bodie for the link.

...the prediction markets — which you see, again and again, touted as having some mystical power to aggregate information, know no more than the conventional wisdom....

From inevitability to pitiful failure to front-runner again in just a few days. There's no hint that the market saw either Iowa or New Hampshire coming, or knew anything beyond the bloviations of the talking heads.

I've long been skeptical about the "Magic" of the market. Like any other kind of magic, it's either illusuory or contrived.

One could also argue that this represents an issue with market efficiency. In many markets, efficient market philosophers to the contrary, all information may NOT be accounted for in the market price. Those who aggregate public sources to achieve a greater situational awareness, actively seek out new information, or who process known information faster can profit, which cause the market to lead wider knowledge. In the case of voting, additional information isn't available or obtainable - the exit polls are as good as it gets, and anything else is pure speculation. One would thus EXPECT the election futures "market" to track the exit polls in near-real time, rather than lead the exit polls.

Certain markets, like the stock market, tend to draw the attention of fewer, better-educated people, and can be expected to be more accurate. When you're thinking whether to invest your client's millions in a corporation, you had better know all about the corporation before you buy.

The broader the market, the less informed its members, the less accurate the market. Ditto how little one has riding on it. Few of us really have much invested in who the Democratic or Republican nominee is.

All this seems obvious to me, but people talk about "markets" like it's a magic word or something. Economics describes human behavior, it doesn't improve or recommend it.

One would thus EXPECT the election futures "market" to track the exit polls in near-real time, rather than lead the exit polls.

The freaky thing is, Intrade was lagging the exit polls.

I saw on CNN how Clinton had a 39/36 edge over Obama, for well over 20 minutes. Intrade still had Obama at over 80%.

I haven't been using Intrade long enough to trust my money to it, but it seemed like Intrade was ignoring the fact that the winner was going to be a toss-up. At least selling Obama down to 60% or so would've been reasonable, especially with the networks declaring the content "too close to call." ... and that market movement did happen, but over the next hour or so, surprisingly slowly.

I was watching the price movements at intrade last night. If I recall correctly, at about 5 PST Obama was trading at about 95 to win New Hampshire, presumably because of the previous week's polls and the conventional wisdom that high turnout was good for Obama. Then the early results came in with Hillary in the lead and there were wild price fluctuations for the next few hours until Obama dropped to 0 and Hillary rose to 1 at the end of the night. The nomination contract markets saw similar price movements (though not quite as extreme obviously).

In other words, the markets were completely blindsided by Hillary Clinton's surprise victory. I follow them because they're by far the best way to turn the conventional wisdom into a single number, but they don't seem to have any special insight into the future.

As others have suggested, the slate article merely states the obvious. Of course the market reacts to polling data rather than the other way around. A perfect market would not always "pick" the winner. A perfect market would determine the probability of an Obama win given the available information. The market predicted a 75% chance that Obama would win, and the fact that he lost is very weak evidence that the market was wrong; if the market was right, you'd expect Obama to lose 25% of the time.

Also, in a sense markets are smarter than the people in them. It takes very few well-informed people to allow markets to track available information closely. The average trader on intrade could be an idiot and it still could work well. There was a recent article on futures markets that claimed they were most efficient when there was a mix of idiots and well-informed people. (Without the idiots, there's no incentive for the well informed to play.)

There's nothing magical about futures markets, but they can potentially digest available information very well.

What these prediction markets do is summarize and encapsulate the conventional wisdom, the poll results, etc., into a single number, without ambiguity or equivocation. Many people have trouble quantifying their insights, and of course many commentators make a habit of being ambiguous, so these markets solve those particular problems. They do not, however, somehow "know" more than the collective wisdom of the participants.

If Krugman had the mental discipline to translate his "insights" into specific predictions for, say, the Treasury futures market, people would see how vacuous and self-contradictory most of what he has to say is. Don't hold your breath.

Guest 1L and wm13—fair enough, but the claims one sees made for these markets are that they're better than the polls and/or the conventional wisdom, perhaps because they're better at predicting things like women switching from Edwards to Clinton at the last minute. We just had a pretty clear test of that hypothesis, and the markets flunked it.

I agree that there are ridiculous claims out there about the power of markets, but I don't see how the markets-are-better-than-polls hypothesis was just tested in the way you suggest. As I understand it, the polls were pointing to an Obama win too. Even if the polls had favored Clinton and intrade predicted Obama, that would be very weak evidence against the hypothesis.

The market predicted a 75% chance that Obama would win, and the fact that he lost is very weak evidence that the market was wrong; if the market was right, you'd expect Obama to lose 25% of the time.

Why do you think that the Intrade value at any given time is equal to a predicted statistical likelihood of winning? Does any particular opinion poll tell you the likelihood of a 6-point swing in the race on the final day? I'm not a statistician, but I think you've made an attributional error.

The futures prices can be more or less interpreted as probabilities. If you can buy an Obama future at $0.75 that would be worth $1.00 if he wins, you'd want to buy if you thought there was more than a 75% chance of Obama's winning. (This is only more-or-less true; it would be true if participants were risk neutral, i.e. maximizing expected returns.) Of course, a market participant is only guessing what the probability is, but that's the point. If enough of the guesses are well informed, then the market's a good predictor.

There is no poll that tells you the likelihood of a 6-point swing, but the market participants (or at least the serious ones) try to gauge the probability as best they can with the available info.

1L: the test is that if the markets were better predictors than the polls/conventional wisdom, they would have started moving before the polls closed. In fact, however, they moved more or less in tandem with the conventional wisdom, or lagged it. Clinton stock went down over the course of the day, presumably because the CW was that high turnout was good for Obama. It only went back up again as the conventional wisdom changed because of the vote tallies and exit poll results that came out over the course of the evening.

Constitutional Crisis: Partially. I never actually said the intrade market was a good predictor. I tried to argue against those who suggest the NH upset is evidence against them, and in doing so, I assumed that the intrade market worked well, perfectly even. I was trying to say that even if intrade was a perfect market (perfect as a predictor) NH wouldn't be surprising. Since I seem to have taken on the role as defender of futures markets, though, I'll try to make the case that intrade is more predictive than conventional wisdom:

I don't know who bets on intrade, but I'm sure a lot of them go with conventional wisdom and/or their own wishful thinking. Here's the thing, though. Anyone with better information than the market as a whole can make money on intrade. Let's say a new poll comes out solidly in favor of candidate X. The talking heads take it at face value, and conventional wisdom goes with them. You, however, being particularly well informed, notice that the poll relied on people with land lines who were classified as likely to vote based on an old formula that shouldn't work well in such a hotly contested election. Your well-informed guess is that the poll was biased toward candidate X. You notice that intrade prices have spiked, along with conventional wisdom, for candidate X. You can make some money. You, and other well-informed participants, sell short on X, and the price of X falls. The intrade price of X is now less than what conventional wisdom would predict because a few well informed participants keep a check on the market in their own self interest. Again, the vast majority of traders can be going solely on hunches or conventional wisdom. It only takes a few participants who are well informed.

Of course exit polls affected the intrade market. Assuming the intrade market is working well as a predictor, it's going to update with all new info. Exit polls are extraordinarily convincing new information. It's true that conventional wisdom moved in the same direction as intrade in response to the new information, but unless you're taking on the straw man with the crystal-ball theory of market prediction, this should be no surprise.

I shouldn't have labeled the crystal-ball theory as a straw man. You're right that a lot of market enthusiasts actually have some vague notion that market predictions are magical. It's just that I'm not saying they are.